Understanding the Medical Loss Ratio

August 31, 2016

The Affordable Care Act (ACA) requires health insurance carriers to spend a specific percent of premium revenue providing coverage (paying claims, providing clinical services and quality improvement). This requirement is known as the Medical Loss Ratio (MLR). If the carrier does not meet the MLR, it must provide rebates to enrollees. The MLR for small group and individual market is 80%; it is 85% for the large group market.

Employer Responsibilities
Employers don’t need to do anything to calculate the MLR; that is the carrier’s responsibility. Carriers who don’t meet the MLR will issue rebates to the “policyholder,” which will generally be the employer. The employer will then be responsible for allocating rebate amounts. The refund allocation process can be tricky. Government and church plans in particular have different rules to follow.

Who Gets the Money?
The amount of the rebate the employer gets to keep depends on whether the rebate is a “plan asset.” If the rebate is a plan asset, it cannot be kept by the employer or used to pay corporate expenses; it must go back to the enrollees. According to the Department of Labor (DOL), an employer must look to the terms of the insurance policy and the governing plan documents to determine if any portion of the rebate may be kept by the employer. If the plan documents are silent, (and many are) then employers should look to the source of the premium payments. The DOL regulations provide:

  • If the premium is paid entirely out of trust assets, the entire rebate will be considered a plan asset and the money will go to employees;
  • If the employees paid the entire cost of insurance coverage, the entire rebate is a plan asset and the money goes to the employees;
  • If the employer paid the entire cost of insurance coverage, the entire rebate is not considered a plan asset and the employer may keep the entire amount;
  • If the employer and enrollees both contributed a percentage of the cost of insurance coverage (the most common scenario), a portion of the rebate is a plan asset and a portion is not. Accordingly, the employer must split the rebate with the employees in the same percentage that premium contributions are split.
  • If the rebate is a plan asset, the rebate must be used consistent with ERISA and DOL guidance. The preferred method is a cash distribution to enrollees. If however, the cost of distributing the rebate is too high or burdensome then the rebates may be:
  • Used to reduce the participant’s portions of future premiums (aka, “premium holiday”); or
  • Used to enhance benefits under the plan, such as the addition of a well ness program or dental or vision benefits.

How to Calculate the Rebate
The DOL guidance does not set forth a specific formula for allocating rebates among participants. Employers are allowed to create their own allocation method as long as the method is “reasonable, fair and objective.” The allocation method does not need to exactly match the premium payments of participants. For example, if the employer pays 60% of the premiums and the employees pay 40%, a rebate amount of $20,000 would be divided with $12,000 going to the employer and $8,000 due to the employees. HHS has clarified that rebates will go to current enrollees at the time the rebate is issued, even though the MLR calculation is based on data from the prior policy year.

While there aren’t any set rules for calculating the rebate allocation, it would be prudent to have a written policy in case of a DOL audit. Other documentation the employer should consider keeping include: whether the MLR rebate is a plan asset or not and any supporting documentation for that decision, verification of additional benefit or premium holidays if applicable, and verification the rebate was distributed.

How to Distribute the Rebate
Before distributing the rebate to employees, employers should make sure that administrative costs related to the rebate distribution were not deducted from the “plan asset” portion of the rebate. Generally speaking, the rebate must be distributed or used as a premium holiday within ninety days of the plan’s receipt of the rebate. The tax consequences of the rebates will depend on how premiums are paid. If the employee paid for coverage under a cafeteria plan on a pre-tax basis then the rebate amount, regardless if the amount was provided as a “premium holiday” or cash payment, would be taxable income.